Fed Monetizes Debt Leading Investors to Embrace Gold

In January gold rose significantly against all major world currencies. In most currencies except in the US dollar and the Japanese yen, gold actually made an all-time-high.

January Performance

GOLD / USD 5.3%

GOLD / EUR 16.7%

GOLD / AUD 16.5%

GOLD / JPY 4.4%

GOLD / GBP 5.8%

GOLD / CHF 16.3%

10-Yr Yield 13.0%

click to enlarge

At the same time, most capital markets have been falling.

January performance

DOW -11.5%

S&P -11.4%

NASDAQ -9.0%

FTSE -6.4%

DAX -9.8%

Nikkei -9.8%

Shanghai -9.3%

The governments around the world are trying to take initiative while private capital is sitting on the sidelines, preferring the safety of government bonds and precious metals.

Investors typically do not trust the governments to implement any effective economic solutions. Moreover, this lack of faith in central planning continues to grow since the US government has no other plan of action than to save the old, compromised and untrustworthy financial system.

What the Federal Reserve together with the Department of Treasury has shown is that they will inject a vast amount of newly created money into a hugely ineffective financial system.

While in the fall of last year, in fear of devastating deflation, analysts were competing in downward projections for the price of gold, now the competition is to estimate the amount of losses incurred by the financial institutions around the world. The maximum assessment is now at $4 trillion, with Nouriel Roubini coming in close second at $3.6 trillion.

But the main problem is not so much in the amount of credit losses or the amount needed for recapitalization efforts but in that the new government is committed to continue to transfer huge capital into the hands of the same group of people who were largely responsible for the world financial crash in the first place. Wall Street, though transformed, will remain in control.

The lack of trust in the ability of insolvent financial institutions to run the modern financial system is moving investors into gold.

An even more important gold catalyst was the Federal Reserve. In comparing the two latest Fed statements, two things stand out. Here is the evolution in wording:

December Statement: “In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.”

January Statement: “In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”

December Statement: “The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.”

January Statement: “The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.”

First, the FOMC sees a threat of deflation and second it is prepared to counter this threat by purchasing longer-term treasuries.

Purchases of long term bonds is the most inflationary move that a central bank can undertake because it represents direct monetization of the government debt and hence an unconcealed debasement of national currency. (This is happening at the same time as the new Secretary of Treasury is chastising China – the main US creditor – for currency manipulation.)

Why did the Fed make such a determined statement, with one member even voting to begin long term treasury purchases immediately? First and foremost, the real estate market is not showing any signs of life. House prices are falling, time required to sell new homes is rising and most importantly, after a steep fall in December, average mortgage rates began to rise again, reaching 5.34% as of last Friday.

Since mortgage rates are closely tied to the 10-year treasury yield, the Fed stands ready to buy government debt and help make housing more affordable via low mortgage rates. The hope is that such action would help put an end to a decline in asset prices and stop the deflationary spiral.

In fact, the latest Fed balance sheet showed that long term treasury purchases have already started, with around $1 billion in notes (5-10-year maturity) purchased for the week ended January 21^st. This is a modest amount, but it is a statement that the Fed is ready to do more than just talk. Traders have indeed sensed this development and Treasury Inflation-Protected Securities (TIPS) (TIP) are also beginning to reflect greater inflation expectations.

Gold investors are also sniffing out the coming price reflation as they piled into the SPDR Gold Shares (GLD) at an increasing rate.

For the month of January, GLD gold holdings rose 8.2% or close to a record setting 63 tonnes. At this rate, GLD will soon surpass Switzerland in its gold holdings, thus becoming the world’s sixth largest gold owner after the US, Germany, the IMF, France and Italy.

If the Fed continues to purchase long term treasuries, it is clear that there is only one way for gold and gold stocks and it is up.

Comments

[yellowhoard:]

I don't know much about banking, but I do know that the fellows that run them and the Fed all seem to know each other. Is it possible that the Fed has winked to the JP Morgans of the world and told them to purchase long bonds, with the assurance that the Fed will eventually step in and monetize these purchases?

Feb 02 09:51 AM

[Carlos Lam:]

Excellent points. Monetizing the debt will -- without a doubt -- lead to price increases in important commodities (i.e. oil, food) because it is the very definition of currency debasement.

I think the main driver of gold's price as of late has been the abject failures of the fiat-based monetary systems of the last 30+ years. The capital misallocations caused by monetary policy have not only debased the United States's currency but have also brought about an unhealthy borrow-and-spend attitude in the American consumer. They have led to an economy that is mostly consumer-based instead of production-based. Only now has it dawned on many individuals that borrowing and spending is not a way to accumulate wealth and attain prosperity.

Feb 02 11:38 AM

[Socialism c...:]

"Investors typically do not trust the governments to implement any effective economic solutions. Moreover, this lack of faith in central planning continues to grow since the US government has no other plan of action than to save the old, compromised and untrustworthy financial system."

And let's follow to the logical conclusion -- the moves suggested by European heads such as Merkel, Brown...and also by the likes of Putin...those who would suggest a new U.N.-based financial control -- will only serve to UNDERMINE financial trust. The further away from home the control goes, the less trusted it is. Americans are finally waking up to the evil that the globalist cabal presents, and will NOT tolerate additional erosion of American sovereignty!!!

Feb 02 01:32 PM

[ignoramusma...:]

Thanks, Boris. You put my feelings into words better than I could have. Right On! This will not end well.

You will find more proof in this article about the Fed doubling the monetary base in one year:

seekingalpha.com/artic...

Feb 02 01:36 PM

[Larry Livin...:]

Boris, I don't see any purchases on treasuries in the last report...only a deduction of $181 mil versus last week...in fact, over the last year, treasury holdings by the fed have been going down...with the fed I have learned that it is more important to watch what they do rather than what they say...(note how they are only purchasing MBSs at a rate of $50B a year versus a $500B commitment....)
www.federalreserve.gov.../

Feb 02 03:43 PM

[Skeptik:]

Yes, the Fed increased their Holdings of US Treasury Bonds and Notes by $2.423 billion during the week, with $921 million of net new purchases of Treasury Notes within the 5-Year, and 10-Year, ‘maturity distribution’.


On Feb 02 03:43 PM Larry Livingstone wrote:

> Boris, I don't see any purchases on treasuries in the last report...only
> a deduction of $181 mil versus last week...in fact, over the last
> year, treasury holdings by the fed have been going down...with the
> fed I have learned that it is more important to watch what they do
> rather than what they say...(note how they are only purchasing MBSs
> at a rate of $50B a year versus a $500B commitment....)
> www.federalreserve.gov.../

Feb 02 04:04 PM

[_richard_:]

"If the Fed continues to purchase long term treasuries, it is clear that there is only one way for gold and gold stocks and it is up."

Ahh yes, the conspiratorial grumblings of the gold bugs again. I note that many have said the same over the past six months, even as gold has plummeted. Of course, the large national reserves held by many governments might well be liquidated during a period of crisis, in order to raise funds for national projects . . . in which case, the store of value implicit in gold would be of little use, no?

Feb 02 05:52 PM

[mkreisel:]

The Fed is actually draining liquidity from the financial system. Since Jan 2, it has reduced its asset from $2.266 trillion to $1.929 trillion. This reduction of $337 billion in liquidity coincided with the drop in stock prices.

Monetizing debt? Not so quick!

Feb 03 04:47 AM

[craigdude11...:]

Richard I am afraid you are correct-with the aim of "those whose aim it is to be in complete control' -LEADING TO A 1 WORLD CURRENCY AND THEN AN ELECTRONIC CHIP "CURRENCY"- why would their plan not include making gold worthless also- SO WHERE SHOULD A PERSON PUT ANY MONEY IN ORDER TO MAKE SOME MONEY TO LIVE ON?


On Feb 02 05:52 PM _richard_ wrote:

> "If the Fed continues to purchase long term treasuries, it is clear
> that there is only one way for gold and gold stocks and it is up."
>
>
> Ahh yes, the conspiratorial grumblings of the gold bugs again. I
> note that many have said the same over the past six months, even
> as gold has plummeted. Of course, the large national reserves held
> by many governments might well be liquidated during a period of crisis,
> in order to raise funds for national projects . . . in which case,
> the store of value implicit in gold would be of little use, no?

Feb 03 09:11 AM

[Larry Livin...:]

Where can I find the link to this info?

Thx


On Feb 02 04:04 PM Skeptik wrote:

> Yes, the Fed increased their Holdings of US Treasury Bonds and Notes
> by $2.423 billion during the week, with $921 million of net new purchases
> of Treasury Notes within the 5-Year, and 10-Year, ‘maturity distribution’.
>

Feb 05 12:08 PM

[mr freddo:]

The common investor will embrace gold in 2009. Normally, after 8 up years in a row, you would expect an overbought situation, but because of our current economic environment, gold is the best bet out there. Treasuries? The next bubble to burst. Equities? Down 40% in 2008. Down 8% in January. Forget about it. Investing in gold provides the most opportunity for capital preservation and the possibility of upside.

Feb 07 08:36 PM